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Devon Energy Turnaround Spared by Activists

Updated from 3:40 p.m. ET to include Third Avenue Management comments and closing share prices.

NEW YORK (TheStreet) -- It took Devon Energy(DVN - Get Report) about a decade to grow from a bit player into the biggest independent energy producer in the United States. Now, it may take nearly as long for the driller to prove it can dismantle that sprawling empire.

Devon's woes are similar to those of Chesapeake Energy(CHK - Get Report), Occidental Petroleum(OXY), and Hess(HES) who over-expanded during the 2000's and found themselves short on cash in the years after the financial crisis. Unlike its competitors, Devon hasn't faced the pressure of an activist investor as it restructures. That speaks to the change underway at Devon and, possibly, the scale of the company's issues.

Devon sold its Gulf of Mexico assets to BP(BP) and Apache(APA) for a total of $8.3 billion in 2010, exceeding the company's initial guidance to shareholders. Devon also impressed in February when it sold some of its businesses in Canada for about $2.8 billion, consolidating the company's international footprint to the Alberta oil sands and the Horn River.

This March, Devon completed a merger of its midstream business with Crosstex Energy. The combined company was then spun into general partner and master limited partnership securities, respectively - EnLink Midstream LLC(ENLC) and EnLink Midstream LP(ENLK) -- that will be controlled by Devon. Generally, Devon has exceeded expectations on its sale and spinoff of non-core business lines.

"We believe this will help unlock value for the company and highlight the value of these assets," Third Avenue Management, a Devon shareholder wrote in October of the spinoff. Devon contributed its midstream assets to the spinoff entities at a valuation of eleven times earnings before interest, taxes, depreciation and amortization (EBITDA), nearly double the company's value of six times EBITDA at the time, Third Avenue added.

Third Avenue Management is among Devon's top-20 shareholders, according to Bloomberg data as of Dec. 31, 2013, and stands out as one of just a few hedge fund investors in the company.

A Push Onshore

To replace those divested businesses, Devon has redoubled its commitment to onshore projects in North America. After acquiring GeoSouthern Energy's assets in the Eagle Ford shale for $6 billion last year, Devon's core assets will consist of the Permian Basin, the Eagle Ford, Alberta oil sands and other onshore assets such as the Mississippi Lime.

Perhaps the restructuring is complete. Devon may now be in a position to grow its oil production significantly and plug cash flow deficits that have stretched into the billions since 2010, according to Goldman Sachs. In that time span, Devon shares have underperformed the SIG Oil Exploration & Production Index by about 25% when factoring in dividends.

Goldman now forecasts Devon to grow its oil production by 50% to 330,000 barrels per day by 2016. That rising oil production could help Devon mitigate its exposure to oversupplied natural gas markets and finance any continued cost overruns.

Weak drilling results in the Utica Shale, the Tuscaloosa Marine Shale and the Cline Shale, however, raise concern about Devon's execution. Goldman analyst Brian Singer initiated Devon with a 'neutral' rating on March 18. The analyst said Devon is valued at a lower-multiple than restructuring industry peers; however, there is greater investor unease about the company's ability to meet capex guidance and execute on its drilling program.

If Devon succeeds in unwinding a mistimed expansion completed by former chief executive and current chairman Larry Nichols, it will be a rare energy industry turnaround orchestrated without the hand of an activist investor.

Three years of restructuring may also be the foundation from which an activist may emerge.

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